For Buyers & Sellers of California Businesses
California Voids Non-Competes. Then There Is the One Exception That Only Exists When You Sell.
The offer came in higher than you expected, or the business you have been circling finally has a number attached to it. Either way somebody just sent over a letter of intent, and it reads like a summary rather than a contract, so it is tempting to treat it as one.
It is not a summary. The LOI is where the terms that decide what each side actually walks away with get set, and several of those terms are governed in California by statutes that have no equivalent in most other states. Your out-of-state broker will not raise them. Neither will the template.
The one non-compete California allows
Everyone in California business knows the headline. Non-competes are void here. Business and Professions Code section 16600 voids contracts that restrain anyone from engaging in a lawful profession, trade, or business, and recent legislation went further, making it unlawful to attempt to enforce a void non-compete and giving the restrained party a private right of action.
Then there is section 16601. A person who sells the goodwill of a business, or who sells all of their ownership interest in a business entity, or who sells substantially all of the operating assets and goodwill of a business or of a division of one, may agree with the buyer to refrain from carrying on a similar business within a specified geographic area in which the business has been carried on, so long as the buyer continues to carry on a like business there. Cal. Bus. & Prof. Code § 16600; § 16600.5; § 16601
If you are buying
That clause is close to the whole deal. You are not paying $800,000 for equipment and a customer list. You are paying for the seller not to open the same business two miles away in March. Section 16601 is the only reliable route California gives you to buy that.
If you are selling
It is a boundary. The covenant has to fit inside the statute. Outside it you may have signed something unenforceable, which is less comforting than it sounds, because the argument about whether it is enforceable happens after closing, on your clock and at your expense.
The part that catches experienced people: which document the covenant lives in
Here is the piece that sale documents get wrong most often. Section 16601 protects a covenant given in connection with the sale. California appellate authority has declined to extend that protection to a substantively similar covenant sitting in a separate employment agreement, one triggered by the end of employment rather than by the sale itself.
Same words. Different document. Potentially different outcome. Fillpoint, LLC v. Maas (2012) 208 Cal.App.4th 1170
That distinction matters because of how these deals are actually built. The seller almost always stays on through a transition period, twelve months, twenty four months, and gets an employment agreement to paper it. It is administratively tidy to put the non-compete in that document. It is also the version most exposed.
The notice most sellers have never heard of
If the business sells inventory from stock, retail, wholesale, a restaurant, a manufacturer that sells what it makes, California's bulk sales law may apply to an asset purchase.
A covered bulk sale generally requires a notice recorded with the county recorder, published in a newspaper of general circulation in the judicial district, and delivered to the county tax collector, a set number of business days before closing. Cal. Com. Code div. 6, §§ 6101 et seq.
The mechanics are unglamorous and the consequence is not. Miss the notice and the buyer can end up answering to the seller's creditors for claims the buyer never agreed to take on.
There are thresholds and exclusions, including value floors and ceilings, so whether Division 6 reaches a given transaction is a genuine question rather than an assumption. It is worth asking before the LOI hardens, because compliance consumes calendar time that nobody budgets for.
The liabilities that follow the business instead of the seller
Two more that regularly surprise buyers in asset deals, where the entire point was to leave the liabilities behind.
Sales and use tax
California can hold a purchaser personally liable for the seller's unpaid sales and use tax, up to the purchase price, unless the buyer withholds enough of the price to cover it and the seller produces a certificate of clearance from the tax authority. Cal. Rev. & Tax. Code §§ 6811, 6812
Unpaid wage judgments
A successor to a judgment debtor can be liable for the predecessor's unpaid wages and damages where the successor uses substantially the same facilities or workforce to offer substantially the same services, shares substantially the same ownership or management, or meets certain other statutory criteria. Cal. Lab. Code § 200.3
Neither of these is defeated by a well-drafted clause saying the buyer assumes no liabilities, because neither one depends on what the parties agreed between themselves.
Before the LOI hardens
- Settle asset sale or equity sale, and treat it as a liability question and a tax question before it is a paperwork question.
- If there is a non-compete, put it in the purchase agreement, tied to the sale and to the goodwill, rather than in the transition employment agreement.
- Confirm that goodwill is actually being sold, since section 16601 turns on that.
- Ask early whether bulk sales notice applies, because it consumes calendar days rather than dollars.
- Build tax clearance and wage judgment searches into diligence rather than into the closing checklist.
- Read the confidentiality and exclusivity provisions the most carefully, not the least. They are usually the only binding parts of an LOI.
The bottom line
A business changing hands at $500,000 or more is not a larger version of one changing hands at $50,000. It is a different transaction, carrying statutory obligations that attach whether or not anyone in the room knew they existed. The purchase agreement is where the price you negotiated actually gets protected, and it is the part of the process people are most tempted to treat as paperwork.
Before the LOI hardens, know which California rules attach to your deal.
CSD Business Law represents buyers and sellers in California business purchase and sale transactions, from letter of intent through closing. [CONFIRM OFFER NAME, SCOPE, AND FEE]
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